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United Utilities - dividend intact, but covid-19 may disrupt

Emilie Stevens, Equity Analyst | 22 May 2020 | A A A
United Utilities - dividend intact, but covid-19 may disrupt

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United Utilities Group Plc Ordinary 5p

Sell: 1,010.50 | Buy: 1,011.00 | Change 31.00 (3.16%)
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United Utilities (UU) revenue rose 2.2% in the year to £1,859.3m. This, together with lower maintenance and operating costs, meant underlying profits before tax rose £32m to £492m.

However, the group recognised a number of exceptional costs this year which meant reported profits fell 70% to £106.8m.These included increased provisions for non-payment of bills, coronavirus related costs and a write down in the value of its Bioresources business.

United Utilities announced a final dividend of 28.40p, bringing the total payment this year to 42.60p. The group is reviewing its dividend policy for the 2020 - 2025 regulatory period as the picture of post COVID-19 environment becomes clearer. It had previously announced it would increase the dividend by at least inflation.

The shares fell 3.2% following the announcement.

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Our view

United Utilities (UU) is a utility as pure as the water that flows through its pipes. In return for providing a reliable and affordable water supply to North West England, and for being an efficiently run business, Ofwat (the regulator) allows UU to earn an acceptable financial return.

With prices set by the regulator and reviewed every five years, earnings tend to be stable, predictable and appeal to investors looking for income.

The current pandemic acts a strong reminder of these qualities. While many companies face significant earnings uncertainty, UU's unlikely to see any dramatic revenue declines.

But while insulated, UU is not immune.

Businesses and homes are under strain and that's starting to show through more clients struggling to pay bills - denting profits this year. UU expects this to increase next year, particularly for businesses.

The global fight against coronavirus means interest rates are likely to stay low for a while, boosting the relative appeal of utilities as income paying companies. However, it's worth keeping a reversal in mind, not only could share prices suffer but debts, which have been steadily growing, will become more expensive.

These challenges come at a time when things were about to get tougher anyway. A new regulatory period has started and the regulator's reduced the level of financial returns UU and its water peers can earn and increased performance targets. As with other businesses, lower earnings tend to mean less generous returns for shareholders.

In light of the current environment UU has said it will review its policy when the coronavirus impact becomes clearer. It had hoped to grow the pay out by at least inflation over the next five years.

The decision took investors by surprise, but at this stage we think it would be wrong to interpret it as anything other than prudence. UU has enough to pay the dividend a few times over, so it's not an issue of can't afford. But the group will lose around 2/3 of its £1.2bn liquidity this year, which suggests a short term liquidity crunch. Plans are in place to raise a more funds this year, so we'd hope to see the previous dividend policy reiterated if and when additional funding is secured.

Despite the challenges and caution over coronavirus, UU has some of the more reliable revenues out there. We think this goes some way to explaining why the shares currently trade at 19.9 times expected earnings, comfortably above the longer run average. The prospective yield is 4.6%, but given the impending review that should be treated with a degree of caution for now.

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Full Year Results

UU's revenue growth largely reflects regulatory price changes. This offset lower business consumption related to coronavirus, a trend which UU expects to increase this year. For every 1% annual drop in business consumption, UU's revenue reduces by around £4 million. While UU said it's unable to predict the impact of this for the coming year it reiterated that shortfalls in revenue are recovered in future years under the regulatory revenue control.

United Utilities earned £22.4m in operational outperformance payments this year, bringing the total for this regulatory period to £43.9m.

Exceptional costs that dented full year reported profits included £56m related to Covid-19 - split between losses at Water Plus, the group's business water joint venture, and increased provisions for bill non-payments. A further £83 million relates to write downs in the group's Bioresources assets while the remaining £158m relates to accounting changes.

Total net regulatory capital investment was £722m for the year, down from £821 the prior year, bringing the total spend over the five year period to just under £4bn.Net cash generated by business fell to £810m, down from £832 the previous year, largely reflecting higher tax payments this year. Non regulatory capital expenditure was £645m up from £624.9m. Together with dividend payments and a change in accounting policy for leases that meant net debt rose to £7.4bn, up from £7.1bn last year. Net debt as a proportion of the regulated asset base was 62%, up from 61% last year. UU expects this to rise further given the current environment.

At the end of March, UU had £1.2bn in available liquidity made up of cash and undrawn credit - sufficient to cover the next 15 - 24 months of the group's cash outflows. However, £722m of this is due for repayment this year, leaving the group with headroom of £436m. UU plans to raise a further £500 - £800m in funding this year.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.